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After a four-year cycle that saw industrial prices increase 45%, cap rates decline more than 150 basis points and transaction velocity nearly double, researchers at Marcus & Millichap Real Estate Investment Services say the industrial market is reverting to more normalized conditions. According to the firm’s Midyear 2008 National Industrial Report, investor demand remains healthy, but the focus has shifted from short-term price appreciation to operating fundamentals.

The researchers say velocity slowed the first half of year compared to the same period last year as investors and lenders moved away from lower-quality assets and the secondary and tertiary markets that had experienced some of the most significant price gains in recent years. While primary markets continued to register appreciation, prices in lesser markets dipped to early-’06 levels. Similarly, the cap rate spread between primary and tertiary markets nearly doubled over the past year to approximately 160 basis points. Cap rates for high-quality propertiesin top markets average 6%, while assets in other markets are selling at caps in the mid-6% to high-7% range.

The report points out that reduced CMBS lending has reduced the pace of large portfolio sales and REIT privatizations, major drivers of industrial sales volume last year. At the same time, it says there is still a significant amount of private equity seeking opportunistic plays. In addition, though foreign investors account for only a small share of total industrial sales, dollar volume from foreign investors was up 22% over last year, with capital flow into US real estate expected to rise further.

In regard to the remainder of the year, the firm predicts demand for high-quality assets will remain strong, preventing a major downward shift in the current median price of $82 a sf. The stability of the median, however, will mask correction for lower-quality assets in secondary and tertiary locations, where financing has become challenging. Nonetheless, the report indicates investment in industrial properties remains attractive, with the sector’s 7.3% overall cap rate for the past 12 months approximately 20 basis points above the retail average and 60 basis points above the office average. Significantly, the industrial cap rate has remained stable for three years.

Looking toward the future, the report recommends keeping close tabs on infrastructure improvements and policy changes at both the local and national level, noting for example that congestion at major ports is forcing some international trade to secondary ports and Mexico, where rail-line improvements are reducing travel times to major US distribution hubs.

It also recommends paying more attention to the flex sector, pointing out that funding of life sciences companies reached an all time-high last year, accounting for 31% of all venture capital investment. As a result, prices for flex properties in top biotech markets, such as San Diego and San Francisco have shown above-average increases. Additionally, it advises looking at adaptive reuse opportunities in land-constrained markets or infill locations, particularly where owners can take advantage of federal or local incentives.

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